Benjamin Graham warned that investing and the pursuit of wealth through markets and publicly traded business ownership involved a very important contingency. Namely, it was non-negotiable that the investor would not put himself in position where he would have to sell stock out of necessity. Most financial analysis focuses on developing the temperament to withstand selling when the market is low. Equal time should be devoted to making sure that a forced sale does not occur due to an unexpected car repair bill, home expense, or some other life event that requires a withdrawal from your investment accounts.
If you have to make a hardship withdrawal from your 401(k) during a year like 2009, decades of accumulated wealth could be lost in an instant due to insufficient planning for adversity. I say that not as a judgmental statement, but rather, none of my articles on my investing will actually lead to improvements over the entirety of your life unless you are in a position to hold onto your investments by choice. If that condition is not present, the wisest course of action is to save up cash, add more cash, and then keeping adding more cash to your household’s balance sheet until it is true. If there is ever moment when it ceases being true, guess what time it is? That’s right–time to add more cash.
As the most recent “Demographics of Wealth” published by the Federal Reserve Bank of Reserve indicates, this is an investment insight that is passed on far better to children in which both parents have college degrees than those that do not. On page 20 of the research study, there is a data point that college graduates (whose parents did not attend college) have a median cash balance of $3,032. For those with a college degree whose parents attended college? Median cash balances of $11,750.
Some of the disparity is due to the higher income that college graduates whose parents graduated from college enjoy over those who are college graduates whose parents did not attend college. But that does not explain all the difference, as the former only earn 21% more annually but yet the cash balance position is almost 4x higher.
I would argue that this is one of those quiet topics that does not receive much attention because it is quietly passed down in college-educated households without any trumpeting of the strategy for a wider audience. This means that if your parents did not attend college, you either need a mentor, need to learn through experience, or comb through data sets like what the Federal Reserve banks produce.
These financial bloggers who point out the seemingly high opportunity cost of cash by noting how much extra wealth could have been created over the past decade if cash positions were invested in something as basic as the S&P 500 Index Fund are missing the point. This analysis is incomplete because it completely ignores the opportunity cost analysis that, say, provided a benefit to an investor in 2009 who was able to pay for a $13,000 in one-time expenses from a $25,000 cash cushion that didn’t require liquidating super-undervalued stock holdings.
When you see the stock market rising, and you are tempted to lower your cash reserves above your usual level, I think you should have to read the following Warren Buffett quote before doing so: “Cash is like oxygen to an individual: never thought about when it is present, the only thing in mind when it is absent.”